Lesson 1: Overview of cost & Management

Accounting

Prepared by: Niruja R

11th August 2017
 Cost accounting
• Cost accounting is a system for recording data
and producing information about costs for the
products produced by an organization.

• It is also used to establish costs for particular

activities or responsibility centers.
 Cost accounting
• The Chartered Institute of Management
Accountants, U.K. (CIMA) defines costing as
‘the technique and process of ascertaining
costs.’
• Wheldon has defined Costing as “the proper
allocation of expenditure and involves the
collection of costs for every order, job,
process, service or unit”
 Why organization need costing
systems
Provide information that management needs to plan and
control
Type of information provided by a costing system and its need:
1. Actual unit cost:
used for cost control,
planning future unit cost,
pricing and production level decisions.
 Why organization need costing
systems
Provide information that management needs to plan and
control
Type of information provided by a costing system and its need:
2. Actual cost of operating a department:
used for cost control by comparing with a predetermined,
budget planning future budget cost.
 Why organization need costing
systems
Provide information that management needs to plan and
control
Type of information provided by a costing system and its need:
3.Forecast costs:
planning,
decision making,
cost control by comparing actual cost with the
forecast.
Terms in cost accounting
 Cost
• ‘the amount of expenditure incurred or attributed on
a given thing’
- CIMA Definition-
• the amount of cash or cash equivalent paid or the
fair value of other consideration given to acquire an
asset at the time of its acquisition or construction
(IAS 16)
• More simply, it can be defined as that which is given
or scarified to obtain something.
 Cost units
• The CIMA Terminology defines a cost unit as a
unit of product or service in relation to which
costs are ascertained.
• Examples:
– A room in a hotel
– A litre of paint
– In-patient in a hospital
 Cost centers
• A cost centre is a production or service
location, a function, an activity or an item of
equipment for which costs are accumulated.
• Examples:
– A department
– A machine
– A project
– A ward
 Cost objects
• A cost object is any activity for which a
separate measurement of cost is undertaken.
• Examples:
– Cost of a product
– Cost of a service
– Cost of running a department
– Cost of running a regional office
 Classification of costs
• Cost classification is the arrangement of items
in logical groups. Costs can be classified in a
number of different ways. Those ways are,
– Element
– Nature
– Function
– Behaviour
 Classification of costs
By nature: grouping costs according to whether they
are materials, labour or overhead cost.
 Direct Materials
Raw materials that become an
integral part of the product and
that can be easily traceable

Example: Tyres in an automobile

 Direct Labor

Those labor costs that can be easily

traced to individual units of product.

Example: Wages paid to automobile assembly workers

 Manufacturing Overhead
Manufacturing costs that cannot be easily
traced directly to specific units produced.

Examples: Indirect materials and indirect labor

Materials used to support Wages paid to employees

the production process.
Examples: lubricants and
cleaning supplies used in the
automobile assembly plant.
who are not directly
involved in production
work.
Examples: maintenance
workers and security guards.
 Classification of costs
By purpose: grouped according to the reason for
which they have been incurred.
Direct Cost
• a cost which is related to a particular cost objective and
can be traced to it in an economically feasible way
Indirect Cost
• a cost which is related a particular cost objective but
cannot be traced to it in an economically feasible way
• indirect costs are allocated to cost objectives
 Classification of costs
By purpose: Direct cost vs. Indirect cost

Direct Trace
Cost Cost
Object
Indirect
Cost Allocate
 Classification of costs
By functions: this is based on the costs incurred in
various function of an organization.
Examples: Production,
Administration,
Selling and distribution.
 Classification of costs
By functions:

Selling Administrative
Costs Costs

Costs necessary to All executive,

secure the order and organizational, and clerical
deliver the product. costs.
 Classification of costs
By changes in activity or volume:
it is based on how a
cost will react to
changes in the level
of activity. The most
common
classifications are:
– Variable costs.
– Fixed costs
– Mixed costs.
 Variable Cost
A variable cost varies, in total, in direct proportion to changes in the
level of activity.
Example:
Your total texting bill is based on how many texts you send.
Total Texting Bill

Number of Texts Sent

 Fixed Cost
A fixed cost is constant within the relevant range. Or, cost which
remain fixed in total; with changes in the volume of the output
for a given period of time.
Example: Your monthly contract fee for your cell phone is fixed for
the number of monthly minutes in your contract. The monthly
contract fee does not change based on the number of calls you
make.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

Within Monthly Plan
 Semi variable cost
Semi variable costs are those which are partly fixed and
partly variable.
 Classification of costs
By functions:
• Product costs:
– are manufacturing costs which are accumulated as
inventories
– It includes direct material, direct labor and direct
overheads.
– Up to sale, these products are shown and valued as
inventory and they form a part of balance sheet.
• Period costs:
– are all other costs of operating the business, expensed in
the accounting period they are incurred.
– e.g. general administrative, selling and financial.
 Classification of costs
By Controllability:
• Controllable - These are controlled by management
like material labour and direct expenses.

• Uncontrollable - They are not influenced by

management or any group of people. They include
rent of a building, salaries, and other indirect
expenses.
 Classification of costs
By Normality
• Normal Cost are the normal or regular costs which are
incurred in the normal conditions during the normal
operations of the organization. They are the sum of actual
direct materials cost, actual labour cost and other direct
expense.
Example: repairs, maintenance, salaries paid to employees.
• Abnormal Cost are the costs which are unusual or irregular
which are not incurred due to abnormal situation s of the
operations or productions.
Example: destruction due to fire, shut down of machinery, lock outs, etc.
 Classification of costs
By relationship with accounting period:
• The capital expenditure and revenue expenditure are
classified under it.
• Revenue expenses relate to current accounting period.
Capital expenditures are the benefits beyond accounting
period.
 Classification of costs
By time:
HISTORICAL COST:
a cost computed after production from records made
concurrently with various steps of production —
contrasted with predetermined cost and standard cost
PREDETERMINED COST:
estimated cost that they are computed in advance of
production taking into consideration the previous
periods.
Element of cost
 Exercise

1. The wages of employees who build the sailboats

2. The cost of advertising in the local newspapers
3. The cost of an aluminum mast installed in a sailboat
4. The wages of the assembly shop’s supervisor
5. Rent on the boathouse
6. The wages of the company’s bookkeeper
7. Sales commissions paid to the company’s salespeople
8. Depreciation on power tools: manufacturing overhead cost
Cost accounting and Cost accountancy
 COST ACCOUNTING
• The Institute of Cost and Management Accountant, England (ICMA) has
defined Cost Accounting as –
– “the process of accounting for the costs from the point at which expenditure
incurred, to the establishment of its ultimate relationship with cost centers
and cost units. In its widest sense, it embraces the preparation of statistical
data, the application of cost control methods and the ascertainment of the
profitability of activities carried out or planned”.

Cost Accounting = Costing + Cost Reporting + Cost Control.

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 Cost Accountancy

• Cost Accountancy means :

– “the application of costing and cost accounting
principles, methods and techniques to the science,
art and practice of cost control”
– It includes the presentation of information derived
there from for the purpose of managerial decision
making.

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 Cost Accountancy includes…
• Cost Accounting
• Cost Control
• Cost Reduction
• Cost Audit

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 Features of Cost Accounting
1. It is a process of accounting for costs;
2. It records all expenditure relating to production of goods and
services ;
3. It provide statistical data on the basis of which future estimates are
prepared and quotations are submitted;
4. It is concerned with cost ascertainment, cost control, and cost
reduction;
5. It establishes budgets and standards;
6. It gives right information to right person at the right time;
7. It is concerned with classification, accumulation, distribution and
control of costs.
 Management accounting

• Management accounting is the sourcing, analysis,

communication and use of decision-relevant financial
and non-financial information to generate and
preserve value for organisations.

• Management accounting is the process of

identification, measurement, accumulation, analysis,
preparation, interpretation and communication of
information that assists managers in specific decision
making within the framework of fulfilling the
organizational objectives.
 Management accounting
• The Report of the Anglo-American Council of
Productivity (1950) "Management accounting is the
presentation of accounting information in such a
way as to assist the management in creation of
policy and the day to day operation of an
undertaking".
 Characteristics of Management
Accounting
• Useful in decision making
• Derived from Financial and Cost Accounting
information
• Exclusively for internal use
• Purely optional
• Concerned with future
• Flexibility in presentation of information
Functions/ Objectives of Management
Accounting
• Planning
• Coordinating
• Controlling
• Communication
• Financial analysis and interpretation
• Qualitative information
• Decision making
 Cost Accounting vs Management Accounting
Basis Cost Accounting Management Accounting
Scope Limited to providing cost Broader scope as it provides all types of
information for managerial uses information
Emphasis Mainly on cost ascertainment and Mainly on planning, controlling and
cost control to ensure maximum decision making to maximize profit
profit
Techniques Standard costing and variance All the techniques of cost accounting
employed analysis, marginal costing and cost but in addition it also uses ratio
volume profit analysis, budgetary analysis, fund flow statement,
control, uniform costing etc. statistical analysis, operation research,
mathematics, economics etc.,
whatsoever help management in tasks
Evolution Its evolution is mainly due to the Its evolution is due to the limitations of
limitations of financial accounting cost accounting

Statutory Maintenance of cost records has It is purely voluntary and its use
requirement been made compulsory in selected depends upon the utility of
industries as notified by the govt. management
from time to time
 Cost Accounting vs Management Accounting
Basis Cost Accounting Management Accounting
Data base It is based on data derived It is based on data derived from
from financial accounts financial accounting, cost accounting
and other sources

Status in In an organisational setup, cost In an organisational setup,

organisation accountant is placed at a lower management accountant is placed at a
level in hierarchy than the higher level in hierarchy than the cost
management accountant accountant

Installation Cost accounting can be Management accounting cannot be

installed without management installed without a proper system of
accounting cost accounting
Scope of cost accountancy
 Scope of cost accountancy
(i) Cost Ascertainment: It deals with the collection and
analysis of expenses, the measurement of production of
the different products at the different stages of
manufacture and the linking up of production with the
expenses.
(ii) Cost Accounting: It is the process of accounting for cost
which begins with recording of expenditure and ends
with the preparation of statistical data.
(iii) Cost Control:Cost Control is the guidance and
regulation by executive action of the costs of operating
an undertaking. It aims at guiding the actual
performance towards the line of targets
 Objectives of Cost Accounting
• To ascertain the cost per unit.
• To provide a correct analysis of cost.
• To disclose sources of wastage of time, material ,
machine etc.
• To fix price.
• To ascertain the profitability.
• To exercise effective control of stocks.
• To advice management on future expansion
 Objectives of Cost Accounting
• To present interpret for mgt. planning.
• To helps in preparation of budgets
• To provide information to right person at right
time.
• To organise internal audit system.
• To formulate & implement incentive bonus plans.
• To organise cost reduction programmes
• To find out costing & profit and loss .